political and economic insights for a topsy turvy world!

Month: March 2017

I started this blog nearly a year ago with reflections and a few predictions on the incredibly turbulent times ahead (this was before Donald Trump and Brexit, see blog #1). As I have been reading and I have been taking an incredibly insightful class on Political Risk, featuring some of the brightest minds at the Eurasia Group, I thought it would be worth the time to summarize and paraphrase some of the more astute comments. The bottom line is we have to expand our notion of what is possible. Increasing nationalism and weak leadership across the globe is increasing the range of potential outcomes. Buckle up, we all need to be prepared!

1st story – Donald Trump. No surprise here, but we need to go deeper.

There is not a lot of global leadership in the world. We have more wildfires than we used to have. No Global Leader want’s to accept the cost and risks of putting them out. When we talk about the #1 Geopolitical risk we need to start with Donald Trump. We have to be able to talk about Donald Trump in an analytical way. Some people think of him as a savior, or as a man-child. We need to go beyond that.

Why is Donald Trump different? He is the first person to serve as US president without serving in the Gov’t or in the Military. Most of the time you have a track-record, a voting record. With Donald Trump we are still trying to piece what types of decisions he will make, and what drives him; and he is probably trying to piece it together it himself.

He is the first president since the 1930’s that does not think that Global Leadership means US leadership. Go back to the Marshall Plan – was it the smartest move in the US politics / or was it a bail-out for Europe? He doesn’t believe the US has to be playing that leadership role. He believes that the US guarantees the security of Japan and Germany. These are the two of the world’s richest countries, why is the US still doing that? The counter argument is that there are advantages to the US playing that role.

Would Donald Trump start something if China went after Taiwan? Will the US support NATO? What about Mexico? Mexico is still thinking this guy is building a wall. Does he have to build the wall? He can’t take that back?

We haven’t had to ask these questions in some time! They are moving markets, adding risk! Whether you think he is an agent of change, or a tyrant… he is moving markets, he is opening up possibilities of change.2nd story – all of our assumptions on oil are changing.

July of 2008, – Oil was selling for $170 a barrel. Folks were writing articles about how this was going to 500. With India, China etc., demand is only going higher. Are we going to run out of oil? Nope. We used to think that we would run out of oil, now many experts believe this may never happen!

Here is what happened: Fracking and technology has now allowed for oil to be pulled from the earth, that no one was thought was possible. Electric and renewable energy is adding energy sources that are not dependent on oil. If you go all the way back to 1980, the only thing that Regan and Carter could agree on was to end foreign oil dependence. If you compare the known reserves of 1980 to today (2 and half more times oil today). We can find new oil, we can produce it, and we can produce it a lower cost.

There are a lot more US oil companies in the market that are able to compete, drill and sell when price goes up. These companies also are able to bounce back quickly, when the price drops they go into bankruptcy. When the price rises, they re-enter the market and add rigs to drill more oil. It’s not just the big oil companies that are adding to the over-supply it is these nimble smaller companies that are adding to the pressure of over-supply (given the technology advances, and the costs of producing oil have dropped).

We are now back in the low 50’s with the price of Oil. Countries that export oil, that really need the money, are in really bad trouble in the long term. When OPEC cuts production they are just trying to establish a floor. When American companies see price going up, companies pop up… We are stuck in this range of 45-65 on oil prices…

If you are Saudi Arabia and Russia they won’t have a problem in 2017, or 2018… but maybe 2019. Venezuela has a problem right now. Venezuela, is in real trouble. Venezuela used to rely pretty heavily on the US given the crude they were producing required a significant refining capability. Their natural partner was the United States.

When does Russia really get in trouble? When does Saudi Arabia really get in trouble?

Saudi’s solution is vision 2030. A project that is trying to modernize the Saudi economy. How much of the human capacity can you use is the question most countries will face? How much talent can you use? Most graduates of university of Saudi are women, yet only 22% of women are employed. Iran is not under any sanctions anymore. There is intense competition between Iran and Saudi on influence and leverage. Saudi’s are losing oil share and losing influence (Syria will stay in power – Iran will not win Yemen conflict). UAE and Oman, allies of Saudi, don’t really want to stir up conflict they want to make money. Saudi doesn’t really have the same friend on the US that it did with GW Bush (given our lack of independence).

Putin has an approval rating of 82%. Putin hovers above the government and finds people that are to blame. 90% of people get their news from state media. Central bank has some independence and credibility. So there are a two rainy day funds: the reserve fund which is almost gone, and the national welfare fund (a lot of that money is liquid). The state of these funds are the leading indicators to judge whether Russia has a problem. After Putin wins the election in 2017 they will need to start talking about cuts… then you want to look at the price of oil, to see if Russia is in much greater trouble.

3rd story – ISIS may be losing territory, but don’t forget about them.

ISIS is going down. ISIS is losing Mosul. If you define ISIS by territory, then they are going down. That’s not the only way to define ISIS, however. It is a brand. People are around the world may look up on the internet and claim they are ISIS.

Once the territory goes away, the ISIS fighters will be dispersed along in the world, and will not quite go away. Who is vulnerable? Europe, Southeast Asia, Middle East countries close by. We can expect that there will be another ISIS (just like ISIS popped after Al Qaeda).

4th story – Europe – It just takes one

Europe has 47 challenges. Not just one 1. There are so many risks that you can make the argument that they will likely manage them, but just one of them has to go badly for things to turn ugly quickly.

Brexit. Article 50 next week. Britain wants to discuss divorce and future agreements. Europe wants to discuss just discuss divorce. This will play out over 2 years. Can end ugly.

Le Pen (far right) is running for election in France. Macron likely to win (centrist party). The story here is neither center-left nor center-right will win. Risk is likely overrated.

Merkel not inspirational. Formidable leader. Close election in Geramny. Bottom line is the next government will be pro-European.

Early elections in Italy, Five Star making populist moves in Italy. Italy dealing with significant economic challenges.

Early Elections in Greece, and overall state of Greece bail-out, Grexit still possible?

Europe has a delicate relationship with Russia- Delicate relationship with Turkey. Erdogan – referendum in Turkey (desires power similar to Russia). Germany and Turkey at odds, tension in media. Turkey and Netherlands tension as well (Netherlands refused to provide Erdogan with airport access). The leverage and deal that is in focus, is teal on migrants that the EU struck with Turkey. Turkey is holding a substantial amount of migrants in Turkey that would have traveled to the EU, and getting paid by the EU to do so. Only 10% of the flow that occurred in 2015 has occurred in 2016 because of this deal.

5th story – and China?

So much is going on in the world that we forget how big of a year it is for China. 19th election, they will replace 5 out of the 7 people of the politburo committee. They make all the decisions. The stakes are enormous. It moves markets. The bottom line: 7 people make all the decisions, decisions that we can’t see. This has never happened before where we cannot see the decision making process! For a country that moves the markets tremendously, to not be able to understand this process will increase volatility for world markets.

They say that you only know what you know. That what you read, consume and surround yourself shapes your perspective on how you look at issues and interact with the world. After visiting major corporations resident in Hong Kong (e.g., HSBC), Schenzen (e.g., Huawai) and Macau (e.g., Sands) – this couldn’t be any truer, and I could not feel more naïve after the trip reflecting. I was in a bubble – of European and American politics, culture and business. Surrounded by a nation caught up in the saga of Donald Trump in the US, walking around in China, I realized how sorely I was missing perspective. I like to think I read a fair bit from various sources – Bloomberg, Financial Times etc, yet what I realized I was also reading from a Western bias. Always trying to put the Chinese Company or consumer into my vantage point (of what a Westerner would expect), and frankly having little understanding of a part of the world where more than half the world’s population lives and is responsible for most of the world’s global growth over the past two decades.

Being in the country, opened my eyes, to what was really happening on the ground. It was fascinating watching the hungry, ambitious and entrepreneurial mindset of the Chinese. The huge strides they have made in short time span, The size of these major global companies (e.g., Alibaba, Huawai) that we as American consumers have not really come across yet. Couple this, with the incredible demographics (1.2bn people, rapidly growing economy etc.) and natural business opportunities afforded many within the firewall of China (that is if you are supported the Chinese Government) – China is truly a dynamic and emerging economy. One that is now rapidly moving from an export oriented – low value chain producer, to an innovator of some of the most advanced technologies on the marketplace today. It now longer can be viewed as a “copy cat” or “lowest cost producer”. This would be a mistake.

Key Trends

Many of these trends were things that I understood prior to visiting China, but were further validated and enriched:

Access to internet is rising tremendously in China and other emerging economies (more than 50% of China now has access to internet) and this is growing rapidly.[1]Mobile. Mobile. Mobile. Forget Desktops and Land Lines. Online retailers/customer interaction platforms are dominating customer time and money. Wechat, Alipay, Amazon – are spreading into different aspects our life

Where needs are not being met in emerging economies (e.g., lack of basic banking services for more than 50% of Chinese[2]) than innovative solutions that leapfrog existing technology are being deployed (e.g., Wechat). I would strongly recommend all watch an overview of Wechat’s capabilities if you have not already: https://www.nytimes.com/video/…/china-internet-wechat.html

Demographics create a competitive advantage for businesses that are growing and have a foothold in China. India and China have nearly 2.6bn people. In the vicinity you have Indonesia, South Korea etc. As the middle class grows, as more get access to internet and get cellphones – the market will just keep growing! Asia has to be front and center in every multi-national with ambition of growing global footprint.

Reduction of cost of goods/raw materials through technological gains (e.g., 3D printers) that allow every day citizens to create and innovate has leveled the playing field and provided massive gains to productivity

China’s firewall of protecting there state sponsored companies has created a breeding ground for companies that have grown and innovated unfettered (Alibaba, Tencent) and creating ecosystems and products that are nowhere in the market. Can American companies compete with this model?

More and more competition between countries is through their major multinational companies, put simply the battleground is between Microsoft, Apple, Google, Amazon and Facebook vs. Alibaba, Baidu, Tencent, Huawei and JD

Given China’s unfair advantage it provides Chinese Companies due its firewall/protection provided, and nature of the mature and hyper competitive US market – it appears that countries like India is where ground zero will be. A democratic country with free elections that allows foreigners to invest with some controls. Already major investments by Amazon and Alibaba should provide

So what’s the insight?

If you are not watching what China is innovating and doing, then you might not adapt (personally and professionally)

Recognize the pro’s and con’s of the different governmental styles being deployed in the US, Hong Kong, China and other Asian nations to support business growth and the well-being of citizens and the corresponding business models that adapt. An example is the Chinese care less about data privacy then Americans, therefore facilitating the ability for Wechat to combines nearly all the features of Facebook, Venmo, Spotify in one App. There are practical implications that can be applied to businesses trying to succeed in China

To be determined if the strong central planning, allocation of resources and protection afforded by China proves to be a better model than Democracy for the long run in the 21st century. One will need to watch for potential bubbles where competition from the broader marketplace does not exist in certain sectors of the economy, as well as the general quality of life / happiness of the populace

Recognize the demographics at play, how they are adapting and where China/India and other Asian nations have significant more head room to grow (a natural advantage for the long haul)

Watch India!

So where to invest?

It is still quite difficult to invest in China. Certain companies have listed on the NYSE or the Hong Kong Stock Exchange, yet with some broader questions on the level of disclosure (may still exist). But as noted above there are some broader trends at play globally. Namely, mobile and internet usage is rising, and consumer buying preferences are rapidly changing. The starkest is brick and mortar retail vs. ecommerce. Take a simple look even in the US, Amazon Revenue from 2012 to 2015 vs. Macy’s revenue picture, doing it with less employees and no retail footprint.

Company

Metric

2015-12

2013-12

Amazon

Revenue ($, bn)

107,006

74,452

# of Stores

0

# of Employees

250,000

Macys

Revenue ($, bn)

27,079

27,931

# of Stores

850

# of Employees

160,000

In summary – tech companies that provide a disruptive growth story with exposure to Asia, are going to be ways to play longer term trends that are changing the way consumers behave and purchase goods.